Headed for a crash

The latest FSA returns for the motor insurance market make grisly reading, but it would be wrong to see 2007 as just another soft market. We, at EMB, believe that there is a big story going on behind the headline figures: that the dynamics of the motor market are going through a fundamental change comparable to those witnessed when Direct Line burst on to the scene in the 1980s.

The catalyst this time is not a new type of insurer but a new type of intermediary. 2007 will go down as the year when aggregators really started to call the tune. The successful insurers of the next decade will be those which respond most effectively to this challenge.

First, let’s consider the raw figures, which show yet again that insurers have been living off their fat. In 2007 they released reserves worth a record £1.1bn — money set aside for claims in earlier years and no longer needed. This had the effect of slicing 13% off the market’s combined ratio, giving the results, which would otherwise have looked dreadful, a veneer of respectability. Even so, underwriting remained in the red. The combined ratio came in at 102, slightly worse than 2006.

Inevitably, generalisations hide variations within the market; some insurers are doing significantly better than others. Among the top 20 companies, Aviva, Provident, Churchill, CIS and Allianz all achieved operating ratios below 95%. Others will have lost money, even after allowing for investment income.

Some small companies also enjoyed outstanding results. Sabre and Tradex have turned in market beating performances for three years in a row. Nor do these figures suggest that direct insurers need to be any more or less profitable than those that prefer to trade via brokers.

A worrying picture

Returning to the market as a whole, insurers of whatever type cannot go on releasing their reserves indefinitely as they have been doing now for several years. The extent of this practice varies hugely. Some insurers did not release any reserves at all last year, or even strengthened them, while others subsidised their motor account to the tune of more than 20% or 30%.

Overall, however, the figures paint a worrying picture: insurers desperate to retain or gain market share are providing the motorist with a generous subsidy. Motor insurance is being sold too cheaply.

To make this observation is not to criticise any of the firms involved. A strong business case can be made for releasing reserves strategically, but undoubtedly crunch time is fast approaching. With the important caveat that the timing is very difficult to predict, we estimate that the pool of reserves will start to run dry in about two years.

Undoubtedly, the key feature of last year was the attempt by motor insurers to put up premiums, which was ultimately thwarted by the influence of aggregators. Like several other organisations, we predicted that rates would rise; in our case we said by about 10%. This was certainly justified by the arithmetic, and it is precisely what started to happen, but then the market hit a brick wall. By the end of the year, it had retreated and, if anything, prices ended slightly lower for the year.

The table below for average private car comprehensive premiums illustrates just how difficult it has been for insurers to sustain higher rates.

“Insurers desperate to retain or gain market share are providing the motorist with a generous subsidy. Motor insurance is being sold too cheaply.”

These rates were made a little more palatable by the fact that claims per policy rose by just 1% — significantly less than inflation generally. This low increase was achieved despite the growing influence of accident management companies, which are adding about 1.5% to loss ratios, considerably more if you add in the cost of their referrals to claimant solicitors. This practice has increased personal injury claims frequency by over 10%. The relatively benign loss environment reflected a drop in accidental and theft claims and, as described in the recent IUA-ABI bodily injury awards study, a subdued rate of escalation in the average cost of claims of personal injury since about 2002/2003.

Petrol prices

There is one other welcome development which came too late for the 2007 year but will benefit insurers going forward. The surge in petrol prices has reduced the amount of motoring we do, and there is some evidence that this has led to a reduction in accidents.

Welcome as these developments are, insurers would be unwise to rely upon them in the future. Difficult economic conditions, such as those we are now experiencing, tend to herald an upturn in claims. As for personal injury, that is greatly influenced by legislative changes and court decisions, which are near-impossible to predict and usually retrospective in nature. The current level of reserving, which is at its lowest since 2001, may come back to haunt some insurers.

Meanwhile, the aggregators march on. It was clear by mid-year just how influential they had become, with insurers cutting rates to compete within aggregator sites that explicitly target renewals. Never mind quality of service or the effort that insurers have poured into their brands, this is all about lowest denominator pricing.

No one knows just how it will all look when the dust finally settles. The aggregators themselves are involved in a dogfight for supremacy and survival, some may try to differentiate themselves in ways other than price, while the FSA may intervene if it thinks the consumer is losing out. Perhaps there will be a public backlash in which consumers — at least those most attractive to underwriters — take a broader view of what represents value for money.

Haves and have-nots

Whatever the outcome, the aggregators are here to stay and the market will have to adapt. While all this is playing out, we expect insurance companies to divide into haves and have-nots: those that possess the reserves to outlast their competitors and those that do not. This will pose some difficult questions for the have-nots. Do they respond by hiking up their rates and sacrificing market share to competitors with deeper pockets or greater staying power? Do they raise additional funds to remain competitive? Or do they reallocate their capital to other lines or even merge with other insurers? These decisions remain to be taken but they will soon start to loom larger.

The insurers that prosper in these uncertain circumstances will not necessarily be those with the most capital. Above all, it will be those with a clear strategy rooted in an accurate and detailed understanding of their markets, strong technical pricing and well-developed risk management frameworks.

Looking to the current year’s results, we expect there to be little change, with maybe a one or two-point improvement in loss ratios overall. Insurance prices will have to rise eventually, and rise sharply, but we do not see this happening any time soon. The UK motor market truly deserves its reputation as one of the most competitive in the world.

Naeem Ali is a senior consultant at EMB, the non-life actuary and management consultant.